The mortgage industry has originated record loan volumes month after month for the last three years. The sub-prime segment in particular has greatly benefited from the boom in the housing market buoyed by interest rates that have approached historical lows. However a second condition is critical to explaining the dramatic expansion of the sub-prime segment: the unprecedented access to large amounts of financial resources which has been leveraged to fund lenders’ growth.
Institutional investors reacted to equity markets far more unpredictably than in the bubble years by redirecting a greater share of their resources to mortgage-backed securities. Lenders understand that this was the perfect storm for the mortgage industry and that the competitive landscape will change soon. In the next stage of the industry life-cycle, lenders are likely to face fiercer competition for both market share and for investors’ financial resources. As a consequence, those who are getting ready for the times ahead by solely developing superior market capabilities will solve only half of the growth equation.
Future industry leaders will be those that are able to increase marketing effectiveness and as well as to deliver higher value to institutional investors in terms of both the quality of the loans underwritten and the investing experience (what does “investing experience” mean? ). To solve the second half of the growth equation lenders need to design effective and efficient business models that address investors’ needs for quality and service by integrating QC and post funding operations in the production pipeline. This enhances both the loan quality and service level without compromising production performance.
GAIN A COMPETITIVE ADVANTAGE USING QC: A SUB-PRIME MARKET EXAMPLE
A leading sub-prime wholesale lender, took full advantaged of the boom in housing and refinancing markets created by low interest rates and availability of funds to finance its growth. By exploiting these favorable conditions and implementing a business model strongly focused on customer service, our client was able to outpace the competition and grew at a double-digit monthly rates for three years between 2000 and 2003. This type of lending, of course, comes with substantial risks, and the value of these loans on the secondary market depends heavily n quality appraisals and underwriting decisions.
During the mortgage boom, the number of loans that had overvalued appraisals increased significantly. Fitch Ratings reflected investors’ concerns with its April 15th 2004 press release, saying that Fitch planned to knock off 10-15% of the home values in about two dozen soft markets where lenders did not use full appraisals. Lenders’ operations are complex, manual, and require the cooperation of several external parties, such as appraisers. The lender realized that more stringent controls on appraisers needed to be implemented.
The lendere decided to redesign a new appraisal quality control model adopting enabling technologies to increase process automation. The lender assessed its existing process for appraisals’ review and then redesign the process introducing gates at each step of the evaluation. The objective of the ‘blocking and tackling process was to measure the severity of the two risk components associated with appraisals: Fair and correct application of appraisal rules . Consistency between appraised and market values.
In the new QC model all submitted appraisals were reviewed to detect errors or inconsistencies that identify riskier appraisals. When anomalies were detected, appraisals were sent to the next control stage for a more thorough and sophisticated analysis. At the end of each stage, appraisals were scored based on the number and severity of the anomalies detected. The overall score allowed the lender to develop an appraiser-specific risk profile that was then aso leveraged to make grounded decisions about future appraisals submitted by the same appraiser.
The system introduced relied on an enterprise document management solution (EDM) to further improve the efficiency of the QC process. By leveraging the EDM’s queue management functionalities the lender implemented a system that allowed QC managers to coordinate the workload balancing activities among multiple locations. Furthermore, providing QC analysts from different offices with the ability to access appraisal files helped the client improve the quality of the analysis by taking advantage of reviewers’ experience and/or specific geographical market knowledge.
Key features of the new operating model: Improving level of integration between QC and production activities. Screening activities were mostly automated by leveraging the existing loan origination system (LOS). The first level of the new control process was entirely automated, and appraisals submitted were screened through a predefined set of criteria, with each criterion assigned a score based on the severity. All control checks at each stage were embedded within the client’s LOS to improve speed and accountability of QC activities.
The strategic value of QC process in the mortgage industry The new Automated Review process logical map 0. Log in loan in Empower Input = Input / Output = Automated Review = Corporate Review Step Description
- Step 1: Appraisal is controlled based on the Step 1: Appraisal is controlled based on the stipulations embedded in Empower. If stipulations embedded in Empower. If appraisal passes this step, it goes directly to appraisal passes this step, it goes directly to the AVM control (step 3). If it fails, it goes the AVM control (step 3). If it fails, it goes to step 2. to step 2.
- Step 2: Appraisal is rated based on the risk Step 2: Appraisal is rated based on the risk implied by the stips attached to it (stip implied by the stips attached to it (stip scores). If the risk is relatively low, the LTV scores). If the risk is relatively low, the LTV and FICO combinations identify a low risk and FICO combinations identify a low risk loan, and the appraiser score is high, then loan, and the appraiser score is high, then the appraisal is eligible for the AVM control the appraisal is eligible for the AVM control (step 3). Otherwise, it is sent to Corporate (step 3). Otherwise, it is sent to Corporate Review. Review.
- Step 3: The appraised value is checked Step 3: The appraised value is checked against the AVM value. If the AVM value shows against the AVM value. If the AVM value shows that the appraised value is within an that the appraised value is within an acceptable range defined by Argent’s acceptable range defined by Argent’s guidelines, then the appraisal is approved. If guidelines, then the appraisal is approved. If not, the appraisal is sent to Corporate not, the appraisal is sent to Corporate Review.
The strategic value of QC process in the mortgage industry AR building blocks: Appraiser scoring model (1) Objective: The objective of the appraiser scoring model is to classify appraisers’ performance based upon the accuracy of appraisals they submit.
Only appraisers that submit at least 10 appraisals are classified Description: Submitted appraisals are reviewed based on the Technical Review Desk Form embedded in the loan system, and are given a score based on implicit severity of the errors / inconsistencies documented by the reviewer. The appraiser rating is updated automatically based on each appraisal’s score.
The solution implemented enabled the lender to monitor and to improve the quality of the loans underwritten, a key factor in determining a lender’s reputation among the investor community and, ultimately, the likelihood for long term success.
The model implemented allowed the lender to detect riskier appraisals and monitor appraisers’ performance. By systematically gathering information about critical third parties and understanding their behavior, our client is able to update QC and production programs to reflect trends and conditions in both housing and investor markets. A final set of benefits delivered had a direct impact on the operating cost baseline for production and QC activities.
The ability to screen and eliminate appraisals that do not match guidelines in the early stages of the loan origination process resulted fewer loans to be review by QC departments. This translated into a more capacity in subsequent stages of the process. Furthermore, analyzing the client’s operations revealed that a significant amount of resources were employed in low-value added activities. The reengineering process and the implementation of enabling technology eliminated these activities and, consequently, reduced the average processing cost per loan.